Wed, Oct 24, 2018

Russia-Iran economic deal: Sanctions relief or political game?

EnergySource by Sara Bazoobandi

Energy & Environment Energy Markets & Governance Geopolitics & Energy Security Iran Oil and Gas Russia

Russian President Vladimir Putin meeting with President of Iran Hassan Rouhani on the sidelines of the SCO summit in Qingdao, China, June 9, 2018 (photo by Russia's Presidential Executive Office).

In May, the US government announced it would unilaterally withdraw from the Joint Comprehensive Plan of Action (JCPOA) and re-impose the sanctions previously lifted or waived. While the re-imposition of sanctions is certainly not welcomed by Iran, it is also nothing new. Iran has long struggled with various economic sanctions and the Iranian economy has suffered under international sanctions for decades. As a result, Iran has looked east for economic cooperation. Over time, the country has also formed multiple mechanisms to bypass sanctions, including oil payments in gold and Asian currencies.

As a result, Russia and China have become the two most important allies of the Islamic Republic. China’s growing energy demand and aggressive export strategies strengthened Sino-Iranian economic partnerships. China has been actively involved in various construction projects and has been Iran’s main trading partner in terms of both oil exports and consumer goods imports. Over the past few years, various high level bilateral negotiations have been held to explore possible grounds for economic collaboration between Iran and China.

Unlike China’s economic activities in Iran, which are motivated by profit maximizing strategies, Russia’s economic collaboration with Iran is driven by pure political considerations. These considerations include countering China’s influence, signalling from Russia that they view Iran as falling within its sphere of influence, and a strategic interest in maintaining this particular relationship.

However, while broader economic relations between Russia and Iran may be more limited than Iran’s relationship with China, energy has been a source of shared interest dating back to cooperation over the Bushehr nuclear plant. One of the most fruitful economic negotiations between Iran and Russia concluded in a 2014 energy cooperation memorandum, whereby Russia agreed to a $1.5 billion per month oil-for-goods swap that would boost Iran’s oil exports.

This was part of an economic cooperation package between the two countries that aimed to attract Russian investors to Iran and offer banking solutions to help Iran access the international banking system. At the time, Iran’s crude export stood at around 800,000 barrels per day (bpd), a historical low. The oil swap deal would allow Iran to increase its export by another 500,000 bpd, making the agreement an attractive mechanism to help Iran to bypass sanctions. Moreover, the economic package appeared to be a useful bargaining chip for Iran during the nuclear negotiations between Iran and six global powers which resulted in the JCPOA.

The oil-for-goods swap was used for the first time after the JCPOA was signed, as Russia received 100,000 barrels of Iranian crude per day for the first time in 2017. To fulfil other aspects of the economic agreement, in early 2018 Russia announced  that the country’s energy companies plan to invest a total $50 billion in the development of oil and gas fields in Iran. However, shortly after the US withdrawal from the nuclear deal was announced, Russian companies started to freeze negotiations with Iranian partners. Considering the severe consequences of doing business with Iran, particularly for Russian companies already suffering under their own sanctions, Russia’s business activities in Iran will likely be affected by the November 2018 return of US sanctions. Major Russian companies will stay away from the Iranian market in order to avoid colossal financial penalties by the US authorities.

Thus, despite its original design, the economic cooperation with Russia will allow Iran to export up to 500,000 bpd at best and have minimal impact on Russia’s overall strategy in global energy markets. However, it can be argued that this cooperation has given Russia the bargaining chip needed to bring Iran on board with OPEC’s production policies. It is speculated that Russia was instrumental in getting Iran on board with the June decision to increase OPEC output by around one million bpd, using the oil-for-goods swap deal as bargaining power to bring Iran in line with this decision.

Saudi Arabia has publicly confirmed that their proposal to increase global output is intended to support the US government’s call to lower prices and avoid a supply shortage and potential price spikes surrounding the re-imposition of Iran sanctions. However, Russia’s motivation was mainly driven by its domestic concerns as the country’s energy companies have been pushing to lift the production cap to cool down domestic fuel prices.

Thus, this relationship between Russia and Iran is key in keeping Iran on board with OPEC decisions and in giving Iran an ally—or at least a strategic partner—to help with its oil export challenges. This suggests not only that Iran needs Russia (which it does), but also that Russia might be using Iran’s lack of options to solidify a relationship that they view as strategic over the longer term.

In a time of changing OPEC politics, upheavals in oil markets, and changing regional dynamics, Russia’s economic collaboration with Iran is driven by pure political considerations even as its business and economic presence in Iran has remained constrained due to the limitations in goods and services that the country has to offer and the price at which such goods and services are provided. This suggests that even if Russia’s political desire is to key close ties with Iran, US sanctions will discourage Russian businesses to enter Iran’s market. Thus, while Russia might prefer to keep the economic package in the headlines, it won’t offer Iran much substance.

That is because Russia is not engaging in Iran for financial profit, as China is, but rather for the bargaining power it brings Russia. The oil-for-goods swap program will, at best, help Russia to fulfil its aims in its domestic fuel market without providing any major sanctions relief for the Iranian economy, which is already suffering from stagnation, currency devaluation, and high inflation. The key question is where OPEC politics goes from here, and whether there is an end game to Russia’s relationship with Iran, or an intended goal of US sanctions on Iran.  

Dr. Sara Bazoobandi is the managing director for Middle East Risk Consulting.